In July 2020, the Chancellor asked the Office of Tax Simplification (OTS) to review Capital Gains Tax (CGT).
The aim was to ‘identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent’.
The review has attracted strong engagement from advisers, businesses, academics, and the public. Given the wide scope of the review, the OTS will produce two reports. The first was published on 11th October. Another will follow early next year and will explore key technical and administrative issues.
What did the report say?
The main aim of the report is to highlight many features of capital gains tax which can distort behaviour. The resulting recommendations from the OTS, across four primary areas, are quite radical. We have organised the main ones under four main headings.
Rates and Boundaries
Currently, rates of Capital Gains Tax (18% & 28% for property, 10 & 20% for everything else) are far lower than their equivalent income tax rates. The report recommends that the government should reduce, or eliminate, this gap. If this happens the report says there should be some measures to allow for (i.e. not tax) inflation. An alternative to this that the report highlights is simplifying the rates.
One area the report recommends focusing on is whether the Government taxes workers and business owners consistently. In particular, the report recommends taxing more of the share-based rewards arising from employment. It also recommends taxing more of the accumulated retained earnings in smaller companies, at income tax rates. Currently, business owners can build up cash in their businesses and, on sale or liquidation, extract funds subject only to lower rates of CGT.
Annual exempt amount
Every tax year an investor can realise gains of £12,3000 and pay no tax. OTS believe this is too high and distorts investment decisions. The report acknowledges that this will vastly increase the numbers of people paying CGT. The report recommends investment managers should directly report CGT information to taxpayers and HMRC, to make tax compliance easier for individuals.
Capital transfers: Interaction with IHT
Currently, if someone dies with assets that have capital gains, they do not incur any CGT. Whoever inherits the asset does so on the basis that only the gains made after they inherit the asset are subject to CGT. The OTS has previously recommended neither should happen.
This report softens this stance. While it does not believe any CGT should be incurred at death it does not believe be a “reset” of the cost of an asset on death.
This is not all unwelcome news as there are knock-on effects which could help with IHT planning with gifts.
Entrepreneur’s Relief (re-named Business Asset Disposal Relief in this year’s Finance Act) allows you to apply a reduced rate of 10% capital gains tax on the profits you make when you sell qualifying assets (such as your business). The Government reviewed this recently and reduced the cumulative limit for disposals qualifying for the relief from £10 m to £1m. The OTS believes the Government should look at the extent to which capital gains tax reliefs on disposal stimulates business investment and risk-taking.
Several respondents told the OTS the rate of tax on the eventual disposal of an investment is an ineffective incentive. They went on to say that incentives for investment if required, should apply at the time the investment decision is made.
What do you think?
There is little doubt that the UK needs to have a plan for raising more tax. There is also a decent case for finding fairer ways of taxing capital. It looks highly likely that Capital Gains Tax will go up in some way.
On the surface, it is hard to argue against the fairness of the changes. However, gains often build up over many years. To link rates to income tax rates when the gain is all realised in one year could produce an unfair result. An alternative tax wrapper which is subject to income tax, Investment bonds, qualifies for a relief based on this fact.
There are questions about how much money this will raise. HMRC estimates aligning CGT and income tax could raise around £14 bn. The big assumption here is that taxpayer behaviour does not change. This could be an unreliable assumption.
What can seem highly tax-efficient one year can be the opposite the next. This is why it is essential to review your planning regularly to ensure it remains suitable for you. This is something we have been doing for our clients for many years.
If you want to know more, please feel free to book in a free no-obligation chat here or get in touch.
Any reference to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of production. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.